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Local Revenue Trend

Originally Posted by Snoopy

The most striking thing I found from looking at the YUMC results is how well profits are growing with respect to revenues. This is great for shareholders. But ultimately a company will run into the 'squeeze the orange' argument. Put simply, you can squeeze an orange harder and harder, but ultimately there will be no more juice that you can get out of it. 'Squeezing the orange' that is the fast food restaurant market and eventually your 'profit growth' dries up unless revenues grow. Over the last five years reported, revenues have grown:

US$6,905m x (1+g)^5= US$7,144m => g= 0.683% (compounding)

But profit growth has been

US$284 x (1+g)^5= US$591 => g=15.8% (compounding)

It is hard to imagine that profit growth could outstrip revenue growth like that going forwards. However, there is another angle that needs investigating. The functional currency of YUMC is the RMB, not the USD. So what happens if the revenue is converted to RMB?

FY2013

FY2014

FY2015

FY2016

FY2017

Adjusted Normalised NPAT {A}

$284m

$254m

$372m

$474m

$591m

Revenue {B}

$6,905m

$6,934m

$6.909m

$6,752m

$7,144m

RMB/USD Exchange Rate

6.1932

6.1428

6.2284

6.6423

6.7518

Revenue

RMB42.764

RMB42.594

RMB43.032

RMB44.849

RMB48.235

Net Profit Margin {A}/{B}

4.11%

3.66%

5.38%

7.02%

8.27%

The revenue growth rate in local currency was

RMB42.764 x (1+g)^5 = RMB48.235 => g=2.44% (compounding)

This is not great when you consider:

1/ local inflation is around 2%
2/ there has been a substantial number of new outlets created over the study period.

But it does show that the revenue is growing above inflation, albeit modestly. This was not apparent when the results were presented in USD.

The functional currency of YUMC is the RMB, not the USD. So what happens if the revenue is converted to RMB?

FY2013

FY2014

FY2015

FY2016

FY2017

FY2018

Adjusted Normalised NPAT {A}

$284m

$254m

$372m

$474m

$591m

$634m

Revenue {B}

$6,905m

$6,934m

$6.909m

$6,752m

$7,144m

$7,774m

RMB/USD Exchange Rate

6.1932

6.1428

6.2284

6.6423

6.7518

6.6174

Revenue

RMB42.764

RMB42.594

RMB43.032

RMB44.849

RMB48.235

RMB51.444

Net Profit Margin {A}/{B}

4.11%

3.66%

5.38%

7.02%

8.27%

8.16%

The revenue growth rate in local currency per annum was:

RMB42.764 x (1+g)^6 = RMB51.444 => g=3.13% (compounding)

This is not great when you consider:

1/ local inflation is around 2%
2/ there has been a substantial number of new outlets created over the study period.

But it does show that the revenue is growing above inflation, albeit modestly. This was not apparent when the results were presented in USD.

ROE Incremental Returns Since Listing (FY2018 perspective)

Originally Posted by Snoopy

Return on Equity

In the 'Buffett Growth Model', it is 'Return on Equity' that is the most important factor in determining earnings for the year. I am happy with assuming a return on equity for Yum China of 18.8% (edit now updated to 18.5%) . In absolute terms, this will be a high number to roll over on itself for the next ten years. Yet the actual ROE over the last three years (the time since YUMC has been listed as a separate entity) have been noticeably higher than this. I am not expecting the high ROE figures from the last three years to continue. Profits have been growing a lot faster than sales. And I expect some re-balancing of costs upwards. Indeed, over FY2018, the 'Net Profit Margin' was, apparently, already shrinking.

I have mentioned before that YUMC came into being as a 'stock split' for the parent YUM corporation. This is a slight simplification of the truth. In fact at the time of the split, YUMC received an outside capital injection of $460m (AR2018 p115). This is as the result of two strategic investors being brought on board the share register:

The net effect of these transactions was to add 19.145m shares (along with the $460m) to the 363.758m shares that came into existence at the time of separation. These shares were added in the very last quarter of 2016 and so already appear on the FY2016 balance sheet information as presented in the table below.

EOFY2016

Change

EOFY2018

Normalised Earnings {A}

$472m

$634m

No. of Shares {B}

383m

392m

eps {A}/{B}

$1.23c

+39c {D}

$1.62

Owner Equity {C}

$2,443m

$2,976m

Owner Equity per share {C}/{B}

$6.38

+$1.21 {E}

$7.59

Return on Incremental Equity / Share {D}/{E}

+32%

It is likely that the net effect of this earlier $460m investment was not felt immediately. So much of the profitability gain apparent from subsequent net capital injection into YUMC (mainly from senior employees cashing in their stock options) is 'piggy backing' on the earlier $460m cash injection not shown above. Thus in my opinion a more meaningful comparison table is this second one:

31/10/2016 (spin off date)

Change

EOFY2018

Normalised Earnings {A}

$472m (for all of FY2016)

$634m

No. of Shares {B}

364m

392m

eps {A}/{B}

$1.30c

+32c {D}

$1.62

Owner Equity {C}

($2,443m-$460m)

$2,976m

Owner Equity per share {C}/{B}

$5.45

+$2.14 {E}

$7.59

Return on Incremental Equity / Share {D}/{E}

+15%

Note that 15% is well below the overall ROE figure of 21.3% achieved over FY2018 and also below the ROE figure of 18.5% over the last five years. 15% return on 'incremental equity' is nevertheless a good figure, the kind of figure that a Warren Buffett would be happy with.

So Snoopy, after all this analysis, have you invested? I've opened an account with Hatch, might buy a few YUMC to get started.

Originally Posted by Snoopy

I am convinced Yum China is a very good company. I particularly like the fact that they can open a KFC restaurant and have all incremental expenditure needed to do that paid back within a couple of years. But successful investment is not just about sharemarket investors buying good companies. What investors need is to buy good companies at good value prices. I see Yum China last traded at $US45.24. Based on last years (2017) results, this represents an historical PE ratio of:

$45.24 / $1.52 = 29.8

This is very high. I would like to wait to see the full results from last year released, to see if such a lofty PE ratio could be justified. Right now, I won't be investing more money into Yum China.

If I was a new investor, I would be waiting for something negative to happen that caused the YUMC share price to fall a bit (bearing in mind YUMC is very strong at its core and the SP should bounce back), and allow a more favourable investment entry price. YUMC has had a series of mishaps outlined earlier on this thread, that dragged their reputation down, for a while at least. The next mishap could be next week. But it could be five years away.

Cricketfan, YUMC fell 3.49% on Friday down to $42.57. That is more than any of the underlying US indices fell and all were down. This stoush between Trump and Chinese President Xi is exactly the kind of event that we investors look for to bring share prices down to more reasonable levels.

Many here will see YUMC as just another US corporation liable to feel the backlash, if not from tariffs, then from an anti-US feeling from the loyal Chinese citizen consumers against the USA. But as you can see below, it isn't.

Originally Posted by Snoopy

If we look at YumChina, their success seems due to their ability to be seen as a Chinese company (the senior executive team is Chinese, they sell franchises to local Chinese) that provide tangible benefits for Chinese workers. Raising the standard of living of the Chinese people is something the Chinese government have been very successful at. And I would say any China based business that produce for all stakeholders benefits in line with the Chinese government's vision will continue to do well.

Watch the misguided masses sell this one down. Then be ready to pounce. But will the share price go low enough to make this a deal that new investor's can't turn down? That remains to be seen.